Foreclosure on vacation property

[origun]

Client bought a home in AZ as a vacation home (hoping to become a snowbird) about 3 years ago and has a mortgage (which is a non-recourse loan). Economic times being what they are, she couldn't use it herself and rented it beginning in mid-2009. Now, in February 2010, she decided to give the keys back to the lender (after receiving 1 months rent in 2010).

My questions:
1. For 2009, should I take depreciation or not?

And to advise her for next year (2010 return):
2. Should she take depreciation for the month or so it was a rental?
3. I assume she will receive a 1099-C at some time. Am I correct that since it is a non-recourse loan, she won't have Cancellation of Debt income?
4. Let's say basis at time she "gave it back to the bank" was $140,000 and FMV is $100,000 and $40,000 if debt is cancelled. For "sale" of the asset in 2010, is it treated as a business property (rental) so she can take a loss? Or is it personal use property so she can't take a loss?

My guess is that she should not take depreciation as it was not intended to be a business property (only a short-term unsuccessful attempt to solve her liquidity problem), she has no COD income and she can't take a loss as you can for a business asset. I'd appreciate the opinions of some of you experts! Thanks.

[Roland Slugg]

Disagree with all your conclusions

In my opinion the T/P should take depreciation from the time the property was converted to a rental, and should continue until it was no longer a rental. According to your post it became a rental in mid-2009 and ceased when it was given to the lender earlier this year.

I also believe she may have a loss on the disposition, subject, perhaps, to offset by COD income. Her basis in the property as a rental was the lower of her cost basis or the property's FMV on the date it was converted to a rental ... again, mid-2009.

[origun]

Thanks Roland

Appreciate your input. Would it matter that she put it up for sale and then rented it out while waiting for it to sell? It was never intended as a long-term rental?